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Defining the limits of discretion in share schemes

Posted: 06/06/2017

It is common for an option scheme to contain a number of matters subject to board discretion. Whether or not a leaver may exercise an option may well be subject to board discretion, for example. A recent case emphasises that this discretion is not absolute.

In Watson & Ors v Ltd (2017) the High Court granted an order for specific performance to allow an option to be exercised in circumstances where the board had purported to hold an absolute veto over the exercise of an option. The High Court found that there was an implied duty on the board to exercise a discretion in a way that was not arbitrary or capricious. In fact the board in this instance had hardly given any consideration to the decision.

The key point to take away is that where directors are given discretion under a share scheme they must exercise that discretion fairly and reasonably. However, the scheme drafting can limit the risk of challenge.

In Watchfinder, the claimants had a right to exercise the option which was subject to a board veto. The natural presumption then was that they should be allowed to exercise this unless the board had good reasons not to allow it. When drafting a scheme, however, it is generally better to allow for the use of discretion in favour of an employee to relax the default rules of a scheme rather than to use a discretion to stop someone doing something they would otherwise have a right to do.

So, the default position under a scheme may be that a leaver loses their options when they cease to be an employee but the board has a discretion to allow exercise. The presumption is that there will be a loss of options, so a failure of the board to exercise a discretion in favour of an employee is less likely to be challenged. However, there still needs to be proper consideration of the matter and a decision can be subject to challenge if the board relies on unfair (perhaps discriminatory) reasons or applies different approaches to leavers in the same circumstances.

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